RMB: Chinese currency could become the next safe haven

In the midst of the global currency wars, China has stuck to its guns. While speculative hopes of rapid gains in the renminbi have dimmed, Chinaâ€™s policy of steady appreciation remains intact, prompting talk of a new safe haven.

â€œAs use of the renminbi spreads globally, it could become a safe-haven currency, especially in a world where the renminbi might gain 2 or 3 per cent a year against the dollar, while the Swiss franc may yield nothing,â€ says Patrick Law, head of greater China trading at Barclays Capital in Hong Kong.

Within Asia, the Singapore dollar and the Japanese yen have been the traditional risk-aversion currency plays. But, for those who can access it, the renminbi could soon join them.

In August, Chinese consumer price inflation fell for the first time in months, following a period where the authorities had briefly tolerated stronger gains in the renminbi. China has often used the exchange rate as one of its policy tools for combating rising prices by reducing the cost of imported food and fuel.

If inflation has decisively peaked, then appreciation may move down a gear, though consensus points to steady gains of between 3 and 5 per cent a year.

A greater worry for investors, however, would be an end to appreciation altogether. In 2008, in the midst of the global credit crunch, China responded to economic uncertainty by halting the rise of the redback â€“ instead resorting to a de facto peg against the US dollar.

With growing concerns of a double-dip recession in the US and Europe, could China do the same thing again?

â€œIn the worst-case recession, there is a risk of a return to the peg. The export sector still employs a lot of people in China,â€ says Puay Yeong Goh, foreign exchange strategist at Credit Suisse, the banking group.

However, most analysts, including Mr Goh, believe things are different this time.

â€œChina is less inclined to return to the peg â€“ weâ€™re at a point where it would be seen as a big step back,â€ says Mr Kotecha. The changing nature of Chinaâ€™s inflation problem could also be a factor.

For now, the main barrier preventing the renminbi from achieving safe-haven status is a lack of accessibility for global investors. â€œIt has the potential to be a safe haven, but that is far from realised,â€ says Nicholas Kwan, head of Asia research at Standard Chartered Bank. â€œIn practical terms, there arenâ€™t many channels to get into the renminbi, and liquidity remains too low.â€

â€œThe question is how fast the renminbi achieves full convertibility. Will we still need such a safe haven in five years? I hope not.â€

In Hong Kong, where residents can purchase up to Rmb20,000 ($3,130) a day, the amount of the currency on deposit in the cityâ€™s bank accounts has soared in the past year, reaching more than Rmb550bn, or 10 per cent of the total on deposit in Hong Kong.

But the investment opportunities remain scarce. Dim sum bonds â€“ the name given to renminbi-denominated debt issued offshore in Hong Kong â€“ cover only 20 per cent of Chinese currency on deposit.

In 2010, there were just 17 dim sum bond issues, compared with 59 so far this year, according to Dealogic, the data provider. Despite this rapid growth in issuance, supply has been unable to keep up with demand. As a result, such bonds are trading at â€œvery rich levelsâ€, says Mr Goh.

That could change if inflation shows signs of falling. the Chinese authorities have been wary of allowing mainland companies to raise funds at low interest rates in Hong Kong and repatriate that money onshore.

For example, yields on a recent dim sum bond issued by Unilever, the consumer goods group, was just 1.15 per cent.

But in August, Li Keqiang, Chinaâ€™s vice-premier, announced a quota system to allow mainland companies to raise up to Rmb50bn in the dim sum market.

It coincided with the third renminbi-denominated bond issue by the countryâ€™s ministry of finance, seen as a vote of confidence in the dim sum experiment.

Malaysiaâ€™s sovereign wealth fund is to sell the first renminbi-denominated Islamic bond, a move that underscores the growing diversification of the products available in the Chinese currency.

The issuance is relatively small to test the interest in the unusual offering, say fund managers and analysts of Islamic markets. The fund, Khazanah, is said to be targeting Rmb500m ($78m).

Fund managers and analysts said the bond seemed to be pitched more at traditional investors in renminbi bonds than at Islamic investors. Several managers of large Islamic bond funds in Malaysia said they were not yet allowed to invest in renminbi products.

Islamic bonds, known as sukuk, and renminbi-denominated bonds are in high demand among investors due to their relatively small supply.

Despite the economic downturn at least 50 companies, including UK-based retailer Tesco, have sold renminbi bonds in Hong Kong worth the equivalent of $8.8bn this year, drawing investors who expect the renminbi to appreciate against the dollar.

April also saw the first renminbi-denominated initial public offering outside Hong Kong. Investors and analysts say Khazanahâ€™s bond should be fully covered due to high demand as well as the dealâ€™s relatively small size and the fundâ€™s investment-grade rating.

Most â€œdim sum bondsâ€ are bought by investors holding renminbi deposits, often built up through trade with China, who have few places to invest those funds other than in low-yield bank accounts.

Trade between China and nations with strong Islamic markets has been growing.

Malaysia is Chinaâ€™s biggest single trading partner in southeast Asia. Last year China signed a trade deal with the Association of Southeast Asian Nations.